Federal Tax Procedure- Audit, Dispute, Resolution
“Preparation time is never wasted time.” Anonymous
This Introduction precedes a 3-Part Series on “Federal Tax Procedure- Audit, Dispute, Resolution for the Cannabis Industry for years 2021 and Onward.” Please subscribe to our newsletter to be notified of future publications in this series, live webinars, and other relevant tax topics for the cannabis industry written by cannabis accountants and tax professionals at www.420cpa.com.
It’s hard enough running a cannabis business on a day-to-day business, without thinking about the IRS. There’s employee relations and inventory management, software and systems, competitors, product selection and processing, the immeasurable laws to stay in compliance with- and last but not least the State and City with their hands reaching into your pockets on a monthly basis. It’s a full-on war for cannabis business owners just fighting the daily fight to stay alive and be successful in this industry.
But in the back of everyone’s mind (especially the minds of the devoted cannabis CPA’s, attorneys, and professionals who look out for you) lurks the dreaded number-letter combinations such as: 280E (and now 471(c)). We’ve discussed and will continue to discuss these IRS code sections in upcoming writings as the final regulations recently came out on 471(c). But that is not why we’re here today.
In our experience, IRS and other audits, tend to begin with an initial year’s examination and may extend back three years if the audit results in the initial year give the examining agent reason to go back further. In the cannabis industry, in California specifically, recreational cannabis was legalized with Prop. 64 as of January 1st 2018. This means that we are nearing the usual statute limitations open for audit with the IRS for this specific industry by the end of 2021.
The statute can be extended beyond three years for a more than 25% understatement of gross income or basis overstatement and can then go back six years. No statute of limitation applies for non-filers or for fraudulent returns filed. Although, we are not going to discuss California audits, their statute generally extends to four years.
As we near the end of the three year IRS statute since legalization of recreational cannabis in a number of states in 2018 we feel it’s important to prepare our cannabis industry clients and other professionals in the industry for this process to dispel fear and also to educate around what the audit, appeals, resolution, and tax court process consists of.
In 2021 we will announce our webinar series in which we will invite various MRB (marijuana related businesses) and adjacent professionals to learn and dispel fear around this process. Preparation is key. With that, you can be sure to take the proper positions on tax returns and also to document those thoroughly. We have walked many clients through this practical thought and action processes so that they won’t fear the process and rather seek the proper professional support throughout it.
An article in Marijuana Business Daily in 2020 discussed “A new report from a branch of the U.S. Treasury Department confirms the Internal Revenue Service is preparing to launch an increase in marijuana industry audits nationwide…” The report corroborates what cannabis industry tax and legal experts have warned about for years – that the IRS is closely watching the marijuana industry and intends to target companies that have failed to pay their full federal tax obligations. In other words, the agency plans to enforce the collection of those taxes.
A report written by the United States Treasury Inspector General for Tax Administration examined the three states of California, Oregon, and Washington for the 2016 tax year and found 59% of marijuana companies had likely underpaid the IRS under 280E. This suggested an estimated $48.5 million dollars were owed. And this was only for 2016 and only for those three states. Calculated out, this suggests to the US Treasury that hundreds of millions of dollars are owed in all 33 cannabis states – maybe more.
The IRS has distributed Participant Guides instructing its agents how to audit marijuana companies, and Compliance Initiative Projects are being rolled out to all 33 states to create a national compliance approach to identify and audit non-compliant cannabis tax payers.
It is ironic that multiple tax professionals and organizations such as the AICPA have requested that the IRS provide guidance specific to statutes as they relate to our industry, including 471(c) and their corresponding treasury regulations, yet this request has not yet been granted. Statutes seem to be clear in the internal revenue code (a higher authority than regulations) and are seemingly contradicted in the final regulations recently issued in January 2021. Therefore, we must walk a fine line of taking a reasonable and supportable tax position- and in some cases, get ready to go all the way to tax court if we want to stand our ground.
Please stay tuned for Part I of “Federal Tax Procedure- Audit, Dispute, Resolution for the Cannabis Industry for years 2021 and Onward” where we will discuss “The IRS Audit Process.” We are licensed California CPA’s who serve clients throughout the state and in all legalized cannabis states in the US. Please feel free to reach out to our office at 420CPA in conjunction with ABFinWright LLP at (310) 237-3070.